The Next New Deal?

Three distinguished economists and professors at Barnard were asked to explore the current economic decline, including the troubled auto industry, and assess ways to break the downward spiral. But as Dr. Alan Dye, chair of the economics department at Barnard College, noted somewhat wryly, economists rarely agree on anything except that they rarely agree. Yet when discussing the prevention of the next Great Depression, a growing number do concur on one thing: Bank bailouts and tax cuts aren’t working. In three separate interviews, Dye and Drs. Perry Mehrling and David Weiman, talk about the country’s recent turmoil, offering some ideas about possible fixes. What is increasingly clear is that the federal government must take charge of the economy in ways Americans haven’t seen since the New Deal and World War II. “It’s really remarkable that economists are in such agreement about this,” affirms Dye.

But the world has changed much since Franklin D. Roosevelt took office and reassured a shaky, fearful public. President Barack Obama and the 111th Congress will have to find new ways to revive and protect the nation’s economic system, often working on a global scale, in a 24/7 news cycle. Today’s politicians need to offer Americans a clear vision for a better economic future, and most importantly, they have to deliver.

Dr. David Weiman

Financial crises are nothing new in the United States, Barnard professor David Weiman tells his economics-history students. In fact, they are surprisingly frequent. He estimates the country has suffered through a major or minor panic about every 10 to 12 years since the end of the Civil War through the Great Depression. When you have a recession that’s accompanied by a serious panic, the recession is then made much worse; the decline is steeper, and it lasts longer than it would otherwise. “That’s precisely the situation we’re in now,” Weiman says.

Many people believe that the stock market collapse set off the Great Depression, and that a burst real-estate bubble and credit collapse signaled today’s downward slide. But the deeper causes of both crises lie in the overextension of credit and long-term structural problems in the financial markets and the economy. According to Weiman, policy-makers are relearning the lesson of the Depression today. They haven’t sat idly by and watched the economy collapse, as many say the Federal Reserve did at the start of the last one. The government has pumped billions into financial markets and bank-rescue plans.

But people are still losing their homes and their jobs in record numbers. They aren’t buying cars or houses. That’s proof, Weiman says, that monetary policies alone can’t reverse the country’s economy decline. The country needs aggressive government spending in infrastructure, health care, and education.

“I worry that we could be headed for something as dramatic as the Great Depression unless the federal government takes decisive action,” he frets.

Because FDR didn’t fully embrace the philosophy of British economist John Maynard Keynes, who argued that governments could keep people fully employed during tough times by operating at a deficit, the government did not take aggressive or decisive enough measures during the New Deal and didn’t act until just before and during World War II. Private-sector investments were not enough. For the next 30 years, the government became the nation’s primary economic manager. Under Truman, Weiman notes, the government institutionalized Keynes philosophy by creating the Full Employment Act, which was a commitment to using fiscal policy to stabilize the economy.

That view of government fell out of fashion in the 1970s, especially after Ronald Reagan became president in 1980, notes Weiman. Reagan convinced voters that big government wasn’t the solution; it was the problem, and government policy changed dramatically. Since then, policy-makers have turned more to tax cuts and monetary policies (interest-rate changes) to stimulate the economy during downturns, rather than deficit financing for social or economic programs.

The tug of war between the opposing philosophies is still at play today, says the economist. President Barack Obama is performing a delicate balancing act between the two sides to gain support for an $825-billion economic-stimulus package, which includes significant cuts, a move some Democrats have renounced, saying similar tax cuts under President George W. Bush didn’t sufficiently encourage consumer spending.

But it’s also clear that Obama wants to create New Deal-type public-investment programs, adapted to changing demands. He’s proposed that the government invest in clean energy, as well as infrastructure and health-care projects. Obama has said his economic stimulus plan will create or save three million to four million jobs. “He could do something that’s very, very dramatic,” believes Weiman.

No matter what, policies should be put in place to insure that no group is excluded from any recovery. No plan will succeed if only certain sectors of the economy benefit. Will women be left out if too much stimulus money is spent on infrastructure and construction, professions dominated largely by men? That’s why spending in health care and education, professions dominated by women, will be critical to any plan’s success, affirms Weiman. He adds, “If the private sector can be reignited, you can’t assume that will ease poverty. We also need other government policies to make sure the benefits are diffused widely.”

Dr. Alan Dye

Dye also believes major public investment in infrastructure and education is central to any economic recovery plan. But that won’t be easy with a jaw-dropping $1.2 trillion deficit facing the country. China helps finance that debt by purchasing U.S. Treasury bills. But the Chinese have to believe the U.S. is a very good credit risk, or that will stop. The country has to come up with a plan to pay down that debt, and invest in education, health care, and infrastructure at the same time. How that can be done in the real world, and what the consequences will be, are anything but certain. “It’s a very tricky thing,” Dye says. “Whatever steps we take have to be taken with an eye towards productivity to build earnings.”

One area where consequences are very important is the auto industry. As someone who has studied the automotive industry for several years, Dye points out that if it were to collapse completely—which is very unlikely—that would make it very difficult for any stimulus plan to work. Certainly, he says, the industry is in trouble, and potentially a lot of jobs could be lost, but what matters is how much of a hit the industry would take.

Further, says Dye, the objective of any government assistance should be to minimize the shock on employment. This doesn’t mean that companies should be saved under any circumstances. Measures could be taken to reduce the impact even if one or more of the big three should have to declare bankruptcy under Chapter 11. Provisions could be made for an orderly reorganization, which could include government participation. The industry employs about 250,000 people, and that number increases to around three million when you include those who make their living serving the car industry in some way, often as suppliers of parts or raw materials.

It’s hard to imagine the economic repercussions if a significant portion of those jobs were allowed to disappear. So a short-term bail out is needed, says Dye, but continuing to bail out the auto industry long-term could have unintended consequences. Industry executives could assume the government will step in to rescue them despite their bad business decisions.

And carmakers have plenty of problems. They haven’t adopted modern production techniques to increase quality control and prevent costly defects on the assembly line. Instead of investing in energy-efficient vehicles, they’ve relied too heavily on sales of gas-guzzling SUVs in recent years. Too many car dealerships have been established, and industry leaders haven’t taken the necessary steps to reduce that number, even though they’ve known for a long time that this was necessary. Now, many of those dealers, even long-time ones, in cities and towns across the country are being forced out of business. This is another part of the industry that needs reorganizing; that will probably happen through the bankruptcies of a lot of these dealerships.

Dye believes the government shouldn’t be in the auto industry. But, he concedes, loaning the auto industry money could be a way to demand real change from manufacturers—no easy task. The United Auto Workers Union refused to accept the wage cuts demanded by Republicans in a $14 billion bailout bill, which died in Congress last December. Autoworkers have been asked to make concessions, but Dye suggests concessions should come from both labor and management.

The industry needs to do more than take a close look at the competitiveness of union wages, Dye says. And the recent federal loans—the federal government offered car companies a welcomed $17.4 billion in rescue funds—have given taxpayers the right to demand that car manufacturers make more efficient, cleaner hybrid cars. Companies need to invest in new factories that can make those cars. Not an immediate option, it has to be part of a long-term plan. “That’s the future,” he avers. “If these companies want to be a bigger part of the global market, they are going to have to be competitive in these niches.”

Innovation can happen in tough economic times; crises present an opportunity to rethink and reorganize. It’s called “creative destruction,” says Dye. During the Depression, car companies increased efficiency by shutting down some factories, which improved average productivity in those remaining. The challenge is making sure that people who can make those innovative, environmentally friendly vehicles keep their jobs. That’s why any plan for the car industry has to strike a balance between the immediate need of preserving jobs and the long-term future of a maturing industry. “There’s no question we’re going to have a serious crisis,” Dye says. “There’s going to be a lot of suffering and we haven’t seen the worst of it, we know that. The question is: How do we minimize the pain? There are some things we clearly know how to change.”

Dr. Perry G. Mehrling

What the country needs most from political leaders now is a realistic vision for the future, says Professor Perry Mehrling. They have to determine what is possible 10 years out, and start building it. “I want to engage our policymakers to look through the crisis,” Mehrling says. “We need to have a believable, plausible vision of the future.”

In a way, he says, that’s what FDR gave the public when he created the New Deal, and Mehrling believes the federal government should heed FDR’s example. It should increase public spending on health care, education, and highways, things already in need of repair. At the very least, Americans would have better schools and hospitals. But, he emphasizes, new government spending isn’t just to fill in for the reduced consumer spending in the short run, but rather should be focused on meeting long-term investment needs of the country.

Public investment is good, but it won’t help banks begin lending money to families and businesses again, he says. Today’s financial markets are nothing like they were in the 1930s and 1940s. The world’s economic engine has depended—but can’t any longer—on the willingness of Americans to go into debt, to buy cars and homes, or finance a college education. That debt is sold mostly to China, usually in the form of Treasury bills. And since the mid-1990s, that debt has been repackaged and sold primarily to European countries as various forms of securities. Such securities are essentially a kind of bond, traded like treasury bonds, whose values are market determined. Subprime mortgages, for example, were repackaged as securities and sold all over the world. But when that credit was overextended, as it was before the Great Depression, and too many people couldn’t make their house or car payments, the entire financial system fell apart. “It snapped like a rubber band,” Mehrling says. “And the pieces flew everywhere.”

So the first thing the federal government should do, he recommends, is restore the value of securities. Until that broken market is fixed, the current crisis will continue. The federal government can do that by selling credit insurance against default for the highest-quality securities. Buying them would be too expensive. But insuring them wouldn’t be. It would be like having catastrophe insurance for the securities market, Mehrling explains. The federal government would insure only the highest-quality assets, because they would be in trouble only during a serious financial crisis, like the one the country faces today. They have already done this, notes Mehrling, in the case of Citigroup’s $306 billion bailout in November and the $118 billion for Bank of America early this year.

The benefits are many, he says. The plan wouldn’t drain banks of much needed cash. Securities could be traded and used as collateral again, and banks would start lending more money. Insuring good securities for up to 90 percent of their value, would make investors want to buy them again without being fearful of losing their money. And once credit started flowing again, the economy would recover. The Federal Reserve and the U.S. Treasury Department have introduced a mechanism for supporting the value of newly issued securities, which will support securitization of consumer loans of various kinds. “These are important steps that I’m happy to see,” says Mehrling. In early January, he notes, the UK decided on a major push in the insurance direction. And he expects that the U.S. will follow suit.

The federal government has begun dipping its toes in the credit-insurance business already. Aspects of the plan were even incorporated in the government’s $700 billion bailout plan. But what the future holds is anything but certain. “This is the new world we live in now, and it’s never been tested by a crisis before,” Mehrling says. “This is a crisis of the entire financial apparatus.”

There is another problem, though, for which Mehrling says he doesn’t have a solution. The world may depend on U.S. consumers to spend more money than they earn, but they probably won’t continue doing it. China and its surplus of savings could step in, reviving world markets by spending more money rather than saving it. But that’s not likely to happen anytime soon. Still, Mehrling says he’s hopeful about the future. Never underestimate Americans. “I do think we can avoid another Great Depression, and because we can, we will.”